Living to the far side of 50 increases the odds each of us will make financial mistakes, and the odds are much higher than most of us realize. Losses, both from mistakes and being victims of scams, are more likely because of changes in the brain, according to recent scientific research. Fortunately, you can take steps to make financial losses less likely.
Here are a couple of recent research findings.
l People pay different premiums for Medigap insurance policies. This shouldn’t happen because policy terms are standardized. It should be relatively easy to choose the policy offering with the lowest cost, but that doesn’t happen.
l Investors over age 72 had annual returns three to five percentage points lower than investors under 50 who had comparable portfolios. Older investors simply were less effective at executing good investment strategies. For example, older investors diversified by holding a large number of stocks, but analysis showed the stocks were highly correlated with each other, so the portfolios weren’t really diversified.
In each of these studies, the people involved tended to be better educated, more sophisticated, and wealthier than the average population. After isolating for other factors, the researchers determined age explained the results.
The unfortunate fact is that mental agility and processing skills peak around age 20. The decline isn’t significant at first, and people are able to compensate for the reduced skills with experience, wisdom, and knowledge. One study that reviewed a number of research projects concluded that the best decisions were made around age 53 on average. (Remember, these are averages. Different people have different experiences.) After that, the decline in mental ability is too great to be offset by experience and other factors. In fact, as people age they are less likely to focus on details or “crunch the numbers.” At the same time, older people are more confident in their knowledge, experience, and instincts. That makes them comfortable making decisions on instincts or the big picture overview.
Another change in the brain is known as the positivity effect. As people age in general they are more positive and optimistic. The reason for this isn’t clear. Some think older people have learned to ignore bad news and people they don’t want to be around. Others think there’s a change in the way the brain works.
Whatever the reason, the positivity effect makes people more vulnerable to financial mistakes, especially to in-person sales pitches. They tend to focus on the potential benefits of a financial choice and down play potential risks. They focus on positives and avoid negatives.
The combination of these traits makes all seniors vulnerable to both bad decisions and frauds. The decreased mental agility means people often need help making financial decisions, such as buying Medigap insurance. So they contact a sales person. The positivity effect and focus on the big picture instead of details makes them vulnerable to a good sales pitch. Seniors who also are isolated and trusting are especially vulnerable to scams and bad decisions.
Here are steps to take to avoid bad financial decisions or frauds.
Before making a decision, ask yourself what you or your children will think about the decision in 10 or more years. This could cause you to focus on details and potential negative outcomes more than you would otherwise.
Seek a range of advisors. Don’t talk to only one sales person before choosing a Medigap policy. Even if you have only one professional advisor, talk to your children or trusted friends and colleagues before making a decision. Don’t let anyone rush you into a financial decision.
Simplify your finances. Don’t have a lot of different accounts at different firms. Consolidate your finances so you can keep better track of things.
Use duplicate statements. Financial services firms usually can be directed to send a trusted friend, family member, or independent advisor copies of your financial statements each month (or give them online access). This person can review the statements for any significant changes in your financial activities.
Establish checks and balances. Seniors often resist asking for help or seeking advice largely out of fear they’ll be considered unfit to manage their affairs. Seeking advice and asking questions is a sign you are acting responsibly and are in control. Don’t be averse to asking for opinions and advice from others, and don’t feel rushed to make a decision. Don’t let anyone belittle you for needing to talk with someone else.
Establish a waiting period. Resolve that you won’t make financial decisions until you’ve taken a minimum time to analyze and think about it. Such decisions rarely are urgent, so you should take at least a week.
Search for risks. Realize the positivity effect exists and fight it. Search for realistic and alternate scenarios when considering any financial decision. Highlight the potential risks and try to quantify the damage that would do to your finances.
Document everything. Don’t be content with oral statements from sales people. You want to see facts and promises in writing. Take notes so you’ll be able to know what was promised, what risks were revealed, and why you made a decision.
RW February 2011.
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